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European leveraged finance: COVID-19 and the flight to quality

What's inside

The European leveraged finance market remains resilient after a year of unprecedented hardship, as lenders dissect credits to determine the best possible deals, from pricing to documentary terms


As we enter 2021, COVID-19 continues to weigh on every decision, from our health to our work and our long-term plans and yet, despite these concerns, European leveraged finance markets have weathered the storm and remain positive about the year ahead

In March 2020, as lockdown restrictions took hold, the European leveraged finance markets ground more or less to a halt. Many feared the worst, as leveraged loan issuance dropped significantly that month and high yield bonds saw virtually no activity at all. Borrowers and lenders alike held their breath, shoring up their finances and waiting to see what might come next. And then, just as quickly, investor sentiment began to improve. By the end of Q2 2020, leveraged loan activity had returned almost to pre-pandemic levels.

And while it slowed somewhat in the latter half of the year, as new waves of COVID-19 swept across the UK and Europe, the final tally was up 11% on the year before—a remarkable achievement, confirming the market’s long-term resilience.

The story in high yield bond markets was equally impressive, ending the year up 10% on 2019 figures, with every indication that it will retain a larger share of the market in the months ahead.

What does all of this mean for 2021?

First and foremost, the influence of COVID-19 will continue to be felt, even as vaccines are rolled out across Europe. Sectors hammered by the first wave—including entertainment and leisure, hospitality, retail, oil & gas and aviation—will struggle to secure financing, having already done what they can to survive. Within those sectors, those that require financing and are able to secure deals are likely to have to pay for the privilege, with leveraged debt either becoming more costly for those whose credit has taken a hit or only being made available on tighter terms.

Second, and in contrast, lenders will turn their attention to high-quality credits or sectors that have found new avenues for growth during COVID-19, such as technology and healthcare.

Third, loan supply will continue to open up—but primarily for those that meet the right criteria. For those well-positioned companies, this flight to quality will continue to offer favourable terms and pricing, and the light-touch covenant packages that were the norm pre-pandemic should remain in place.

At the same time, an anticipated recovery in mergers and acquisitions and leveraged buyout activity will provide an additional lift in the early months of 2021.

And finally, the issues that were front of mind pre-pandemic will continue to influence borrowing and lending decisions, especially environmental, social and governance (ESG) factors—investors will take a positive view of any credits that incorporate ESG criteria in a meaningful way. This will no doubt drive this trend in the months ahead as recovery takes hold and global debt markets return to growth.

Living dangerously: How has European leveraged finance fared in the pandemic?

  • European leveraged loan issuance is up 11% on the previous year to €227.1 billion
  • High yield bond issuance is up 10% on 2019 figures to €100.5 billion
  • Average yields to maturity on high yield bonds widened from 3.8% to 4.7% in 2020
  • Average margins on institutional leveraged loans increased from 338 bps in Q1 2020 to 401 bps in Q4
stock market

Five trends driving post- COVID-19 documentation

  • Terms will move back in favour of borrowers/issuers (for now)
  • Lenders will hold the line in key areas
  • Forecasting and structuring will be a post-COVID-19 challenge
  • Pricing will continue to bifurcate by sector and rating
  • Competition will encourage private debt and syndicated markets to converge

Buyout rebound reflects optimistic outlook

  • Private equity deal value in Europe totalled €26.5 billion in Q2 2020, the lowest quarterly figure since Q3 2013
  • High yield bond issuance for leveraged buyouts (LBOs) in Europe is up 39% year-on-year to €7.8 billion
  • European leveraged loan LBO issuance declined by 6% to €36.8 billion year-on-year
Financial stock display

Market reset could trigger restructurings in 2021

  • In March 2020, credit insurer Euler Hermes forecast a 43% increase in insolvencies in the UK in 2021, as well as a 26% uptick in France and 12% in Germany
  • By December 2020, ratings agency S&P was forecasting European defaults rising to as much as 8% by the end of 2021
Financial stock display

European CLOs: A mere flesh wound?

  • New issuance of European collateralised loan obligations (CLOs) peaked at just under €4 billion in October 2020 from 12 deals—the highest monthly level since October 2019
  • European CLO new issuance declined 26% year-on-year, with refinancing volumes falling from €6 billion in 2019 to zero in 2020
  • By the end of March 2020, credit ratings on an estimated 10% of loans held by CLO managers were downgraded or put on notice of downgrade—however, the rate of loan downgrades eased and stabilised in the second half of 2020
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Sector split: The very different impact of COVID-19

  • Weighted average bids for healthcare and telecoms credits both priced at approximately 99% of par by the end of 2020
  • Entertainment and leisure and retail loans, meanwhile, priced in the 90% to 93% of par range
  • Between March and September 2020, only the transport and automotive sectors suffered more ratings downgrades and negative outlook changes than the oil & gas industry
Financial stock display

Leveraged finance: The United States versus Europe

  • In the US, leveraged loan issuance for 2020 totalled US$861.7 billion, a 4% year-on-year decline
  • The high yield bond market in the US saw a 69% year-on-year increase to US$428.3 billion
  • The European leveraged loan market increased by 11% to €227.1 billion year-on-year
  • The region's high yield bond market was up 10% to €100.5 billion

European leveraged debt in focus

Selected European leveraged loan and high yield bond markets by volume and value

What is shaping sponsor debt decisions for 2021?

  • Leveraged loan issuance for European LBOs dropped 6% year-on-year
  • High yield LBO issuance, however, was up 39% year-on-year to €7.8 billion
  • European direct lending volumes fell from 189 deals in 2019 to 138 deals in 2020
  • Ares Management underwrote the largest unitranche on record with the provision of a £1.875 billion financing package for Ardonagh


After years of warnings about maturity walls, impending cliff edges, downturns
and interest rate hikes that failed to emerge, COVID-19 was the event that brought
everything to a temporary standstill—but there's every chance that the markets will
explode with activity in the months ahead

Financial stock display

Market reset could trigger restructurings in 2021

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  • In March 2020, credit insurer Euler Hermes forecast a 43% increase in insolvencies in the UK in 2021, as well as a 26% uptick in France and 12% in Germany
  • By December 2020, ratings agency S&P was forecasting European defaults rising to as much as 8% by the end of 2021

There have been fewer European insolvencies and restructurings than anticipated during the COVID-19 pandemic, but distressed deal activity may accelerate as soon as economies are finally able to reopen.

The European Central Bank's expanded €1.85 trillion quantitative easing programme, coupled with tax deferrals, state-backed loans, employee wage support schemes and a focus, among lenders, on liquidity rather than financial covenants have all helped to keep companies afloat.

Lenders have also been reluctant to foreclose on debts and crystallise losses when valuations and value breaks in capital structures remain unclear, in particular with a backdrop of regulator announcements warning lenders against hasty action in the face of COVID-19 challenges, and a number of European jurisdictions introducing legal restrictions on such action.

A new round of full lockdown measures introduced in various European countries early in 2021 has seen the further extension of job retention schemes and state-sponsored loan and liquidity measures, but as soon as these support efforts wind down and markets reset (most likely in the second half of 2021), a wave of distressed situations are expected to come to market.

Back in March 2020, credit insurer Euler Hermes was already forecasting a 43% increase in insolvencies in the UK, as well as a 26% uptick in France and 12% in Germany in 2021.8 By December 2020, ratings agency S&P was forecasting that default levels could climb to as much as 8% by the end of September 2021.9

At some point in the next 12 months, it is likely that borrowers and lenders will have to assess whether earnings are going to recover to pre-COVID-19 levels or whether capital structures established pre-pandemic (or indeed post-pandemic) remain appropriate, with higher levels of debt incurred to support liquidity through the crisis.

Some companies in sectors directly impacted by lockdowns— from aviation and leisure to hospitality—managed to stay afloat in 2020 by tapping into markets to shore up liquidity reserves.

Jet engine maker Rolls Royce, for example, launched a £5 billion recapitalisation plan that included a bond and loan package, as well as a rights issue, to navigate disruption due to COVID-19, while UK food and fashion retailer M&S raised its first high yield bond after losing investment-grade status early in 2020.

With lenders focused on liquidity, some borrowers have taken the view that cash raised now can be repaid later in the cycle when economies recover. The question is whether these changes to capital structures are sustainable and what proportion of future cash flows will be required to service these loans and bonds over the long term. If companies are found to have borrowed too much too early, this may trigger restructuring deals long after the pandemic has passed.

The anticipated rise in European defaults in 2021, according to ratings agency S&P


Troubled credits flushed out early

Distressed deals and restructurings that came to market in 2020 typically involved credits that were already on restructuring candidate watchlists, especially in the UK. Sectors facing long-term headwinds, including physical retail, real estate and casual dining restaurants, account for a large proportion of the recent casualties.

For example, clothing group Arcadia and the department store chain Debenhams went into administration in November 2020. In the restaurant space, Casual Dining Group fell into administration in July and Carluccio's was bought out of administration in May.

The headwinds faced by these sectors have prompted a knock-on effect for real estate companies, with retail and restaurant administrations reducing occupancy rates and rental income. The impact of lockdowns on rental revenue and a £4.5 billion debt pile, for example, saw the UK's largest shopping centre operator, Intu, fall into administration in August. British Land, meanwhile, reported a 15% decline in its retail portfolio as annualised rents fell by £11.6 million.

Restructuring activity in 2021 is likely to continue along sector-specific lines, though more industries could move onto watchlists if consumer and client habits show long-term changes following COVID-19. It is also worth remembering that some businesses that were performing well pre-pandemic are currently on watchlists purely because of the sector in which they operate (e.g., leisure, aviation, etc.). They may be more than capable of bouncing back, depending on how long the pandemic continues.


Considering all options

Some companies turned to very 'light touch' restructurings, for example by resetting covenants or extending maturities to bridge to an anticipated recovery post-pandemic.

Others sought out more cash from existing lenders or third parties at the senior or super-senior level to provide emergency liquidity and extend runway. For example, in October 2020, French hotel property business AccorInvest held talks with 19 banks regarding a possible restructuring of more than €4 billion of debts. In August, aviation company Swissport announced that it had secured bridge financing, which was then used to facilitate a restructuring that completed in December 2020.

Financial sponsors provided cash injections for some. Hunter Boot, best known for its Wellington boot lines, received a £16.5 million cash injection after a period of weak trading from existing shareholders, including Goldman Sachs, Searchlight Capital and Pentland. Sponsors will need to assess whether these injections were enough to stave off a more fulsome financial restructuring later in 2021.

Borrowers also made use of restructuring tools such as company voluntary arrangements (e.g., shoe retailer Clarks), schemes of arrangement (e.g., Swissport) and restructuring plans (e.g., airline Virgin Atlantic and casual dining operator Pizza Express).

A number of these processes were used by these companies to implement debt-for-equity swaps— including Swissport, Pizza Express and New Look, the latter of which was implemented despite its CVA being challenged by landlords.

Special-situations firms will also provide a route out of distress in 2021. According to Preqin, special situations fundraising in April 2020 was more than triple the amount raised in the first quarter of the year.10 These investors will be on the lookout for deals—and with restructuring activity likely to pick up in 2021, there will be plenty of options.


8 "Calm before the storm: COVID-19 and the business insolvency time bomb". Maxime Lemerle. 16 July 2020. Euler Hermes.
9 "Europe's High-Yield Default Rates Rise as Credit Cycle Turns". Fitch Wire. 30 March 2020. Fitch Ratings.
10 "Where does debt sit on the LP radar?". Op cit.



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